Valuing a dental practice for sale: First-hand lessons learned

As part of our family’s decision to relocate to Seattle, we went through the step this year of selling our orthodontic practice and the building in which the practice operated. Later this year I’ll have a more detailed summary of the process of selling a practice, but in this article I’d like to focus on the building practice valuation process, and what we learned.

Rich McIver

The Practice and The Building

The sale of Kingwood Orthodontics involved two major components, the sale of the building, and the sale of the actual practice. Each was valued separately, by different people, and using entirely different metrics. And while the ultimate purchaser combined the purchase amounts into a single purchase price, it’s more elucidating to examine these two valuations separately.

Building Valuations: An Inexact Science

If you’re selling a residential home located in a neighborhood, there are literally dozens of comparable homes and recent sales by which even an amateur can reasonably accurately value your home. Therefore, obtaining a formal appraisal isn’t something that a seller would normally pay for, and typically only if the purchaser is financing their purchase will one be obtained at the behest of the lender. And even in those instances, the appraisal is largely a formality, as a brief internet search of comparable homes and recent sales will yield a relatively tight range of home valuations.

By contrast, valuing a commercial building with a specialized purpose (e.g. orthodontic practice) is the wild west by comparison. That’s because in many situations, the location of a dental or orthodontic practice is in a semi-residential area where there are simply not many other commercial buildings to compare it to. Reducing the applicable sample size yet further, there are typically only a handful of other dentists or orthodontists in a neighborhood, and few that will be in similarly situated real estate. That means the pool of ‘comparable buildings’ is virtually non-existent in most cases.

Thus, lenders turn to specialized commercial real estate appraisers to value the property. These commercial appraisers use specialized software that attempts to compile a sufficient number of comparable properties by either expanding the geographic scope of their search, or expanding the type of building considered comparable (e.g. including all medical related building types). This software based appraisal is then supplemented by an on-site visit to the property.

While all of this makes sense in theory, our actual experience with how this commercial real estate appraisal process plays out was less impressive.

Having conducted our own internet searches and knowing that there were almost no real comparable properties, I was initially optimistic that a manual visit by the appraiser would fill for the fact that there weren’t many comparable properties Having met the appraiser on-site it became quickly evident to me that this was merely a box-checking effort to confirm that the building did in fact exist, and that it was in approximately the same condition as the seller and buyer had described it previously to the lender. In total, the appraiser spent approximate 7 minutes inside the building. Thus, the valuation method was almost entirely reliant on trying to use comparables that weren’t really close matches in terms of geography, size, condition, or purpose.

Thankfully, our building valuation came back at a level sufficient to support the asking price and closing of the property. I, however, was generally surprised at what I perceived to be a lack of formality, and methodology employed in reaching a commercial valuation. That observation, I believe, might encourage the reader to seek out their own seller initiated commercial appraisal when selling a building, just so that there is more than one written valuation of the building.

Practice Valuations: Cash-flow Matters, Equipment Does Not

While the sale of an orthodontic or dental building is relatively rare, as most dental professionals lease office space, the sale of a dental practice, by contrast, is relatively routine. Despite that, however, there were still some surprises that I think are interesting to share.

First, the value of a dental practice seems largely determined by the valuation methods set by the lenders. That is to say, the number of dental practices purchased for cash is quite small, such that the pricing for dental practices has come to mirror a banks valuation methodology as opposed to how much a practice might appeal to an individual dental purchaser.

That distinction means that first and foremost what determines a practice’s valuation is free cash-flow. Things like the age of the dental equipment, how well it has been maintained, the quality of the staff, the reputation of the dentist in their community, how strong their network of referring dentists is, are all largely immaterial when determining for the practice valuation.

One pointed example is that Kingwood Orthodontics had just purchased a few months prior to the sale a $40,000 iTero intraoral scanner, which replaced the need to take dental impressions. The seller’s lender flatly informed us, however, that from the bank’s perspective, digital impressions are equivalent to physical impressions insofar as the both serve the same purpose of allowing the orthodontic practice to treat patients. And while the former might be more convenient to patients and in theory attract some additional new patients in the future, the fact that the practice owned the additional technology made no significant difference in the valuation of the practice.

So, if one were planning to sell their practice in the near future, he / she would be wise to forego investing in new equipment if that equipment is at all optional. And secondarily, the dentist should focus on increasing free cash-flow for the 24 months preceding the sale by eliminating any semi-personal expenses from the business, and working extra hard to develop additional revenue.

Great insights you have provided into the sale of a dental practice. Sometimes the old dentists that were getting enough customers have lost their clientele due to old population’s migration or growing up. They usually want to sell their dental clinics to others and this is where some great advice from you would be helpful to them.

I like that you mention how a valuation on a commercial medical practice is far different than something like a valuation on a home. It makes sense that homes are relatively easy to put a value on because of how comparable they are to each other whereas a dentists office would have much more than goes into the value. This is definitely something to keep in mind because getting the help of an experienced commercial appraiser as well as an agent to help sell or buy could be a very effective way of making the process smoother. Thanks for the post; I didn’t realize just how complicated the process of buying or selling a medical practice can be so this information could really help any novice.

That is interesting to learn that the value of a building and the value of a practice are actually measured separately. If I were ever to get a dental practice for sale, I would be sure to keep both of those matters in mind. Having a good location and quality practice for a dental location are both important to a successful clinic.

May I please ask u a few questions re: practice appraisal?
Can u get a rough idea of the value of the practice by tax returns and P & L statements?
Would u share the name of whom u used to appraise your practice?
Did u compare your end result with offers from Transition Whale or Smiles for Life?
Thank you very much for your post!

I did not write the article above but I am a valuation professional and I can address some of your questions.

1. Can you get a rough idea of the practice value by reviewing tax returns and P&L statements? Yes and no – tax returns and P&L’s provide an indication of cash flow and, as the article above states, cash flow drives the value of all businesses. A good appraisal will calculate several indications of value, including a) the discounted value of a forecast of future cash flows and b) one or more market approach methods. The market methods are what appraisers use to develop valuation multiples of earnings and other financial metrics. Thoughtful appraisers use the results of the different indications of value to triangulate on the valuation conclusion.

So that is more the No part of my “Yes and no” response. The Yes part is that if the person who is looking at the tax return or P&L statement is current on dental practice valuation multiples, they can have a reasonable idea of the value pretty quickly.

2. I can’t tell you who the author used to appraise the practice but I can help you if you wish. You can reach me by e-mail at chris.lucas@lvg-llc.com.

3. I don’t know if the answer to the question about Transition Whale or Smiles for Life.